Using inflation to create jobs? There is a better way

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Do you care about inflation? I guess I do, in an economist-like way, because I know that the Bank of Canada cares, and that it will set policy based on how much inflation it sees (which is not a lot, apparently, going by the central bank's latest rate decision and accompanying statement, issued Wednesday).

But you certainly don't have to read a Bank of Canada communiqué to know that inflation is pretty dead. There are lots of inflation indicators that the bank tracks and I do too, but none are any more telling than the fact that Canadian retailers now feel compelled to put in Black Friday sales and Cyber Monday ones as well, as a way to move merchandise. I even got a few e-mails from retailers assuring me that their Cyber Monday sales would not end until Tuesday, at least.

That all seems great for bargain hunters. But is it good for job hunters?

A new paper from the U.S. National Bureau of Economic Research (NBER) suggests that there is a trade-off between creating jobs and keeping prices low in the periods following recessions. For economists, this is an old theory. The Phillips Curve, the brainchild of British economist A.W.H. Phillips and presented in 1958, suggested that countries could pick between a menu of choices on inflation and unemployment. Want to get inflation down a bit? Decide that you are going to accept higher unemployment. Want to drive the unemployment rate down? Allow inflation to accelerate. Simple, really.

The Phillips Curve, in its simplest form, went out of fashion in the early 1970s, when in the aftermath of the Organization of Petroleum Exporting Countries oil shock, it was clear that you could get, simultaneously, scary-high unemployment and high and rising prices. Since then, the theory has been revised a few times. The conclusion is that boosting inflation to reduce unemployment may work in the short term, but you end up with lower real (inflation-adjusted) wages, and ultimately may not make as much of a dent in unemployment as you intended.

The authors of the NBER paper found that there is a sizable trade-off in the short term for countries that want to swap inflation for unemployment. But it is not a recipe that has been tried much in developed countries over the past few years. That's arguably an issue for Canada, but at least Canadian employment is at its pre-recession level (and has been for years). Things are different in the United States, where the unemployment rate is still well above where it was in 2008, and where even Black Friday and Cyber Monday sales were apparently insufficient to move enough merchandise for retailers this year. More discounting – which is to say, deflationary pricing – is clearly ahead.

So is a deliberate bout of inflation the answer? Probably not. What the authors of the study found – and it is a pretty textbook response anyway – is that if you choose inflation, a few people may get jobs but everyone sees a dip in their inflation-adjusted wage, so everyone ends up being able to buy less. It's not a very palatable choice.

The authors do offer one glimmer of hope in terms of a policy that can create jobs and keep inflation in check: a freer flow of credit. That one is out of the hands of the policy makers, though; as both the Bank of Canada and the Federal Reserve have learned, you can cut interest rates to whatever you want, but you cannot make banks lend. To get that to happen you have to buoy lenders confidence in the economy, and that is not something that can easily be done with any policy.

Linda Nazareth is a Senior Fellow at the Macdonald-Laurier Institute. Her book Economorphics: The Trends Changing Today into Tomorrow will be published by Relentless Press in January. www.economorphics.com